Merrill set for Senate grilling

Firm's Enron deals, research practices eyed

By

CBS.MarketWatch.com

NEW YORK (CBS.MW) -- Merrill Lynch will be the subject of a Tuesday Senate hearing in which lawmakers are expected to allege that the brokerage firm engaged in transactions that led to misleading accounting at Enron and compromised Merrill's investment ratings.

Merrill is also likely to be questioned about allegations in a published report that the firm replaced an analyst who covered Enron's stock for its research department after Enron expressed displeasure at his "neutral" rating on the stock.

The New York Times reported Tuesday that Merrill replaced the analyst, John Olson, after he was criticized in an internal memo that said Merrill had lost underwriting business because of Enron's "visceral" dislike for Olson. Read full story.

One of the memo's authors, Schuyler Tilney, is the head of Merrill Lynch's energy investment banking business and last week revealed he would not testify before today's hearing. He was subsequently placed on paid administrative leave at Merrill.

Merrill said Tilney "made his decision based upon the advice of his counsel after learning of a Department of Justice investigation into a transaction being reviewed by the Senate subcommittee."

For Merrill Lynch, Tuesday's hearing is expected to include allegations that the firm improperly aided Enron in deceptive accounting practices surrounding an investment in a string of Nigerian power barges, people familiar with the subcommittee investigation said.

The probe found that Merrill invested $28 million in the barges at Enron's request. The investment allowed Enron's Africa unit to book sales income of $12 million in its 1999 financial statements, the people familiar with the probe said.

Merrill agreed to participate in the transaction only with Enron's guarantee that Merrill's interest would be bought out within six months with a $250,000 up-front fee and a 15 percent guaranteed return on Merrill's investment, the probe found.

After six months, LJM2, a partnership created by Enron's then-chief financial officer, Andrew Fastow, purchased Merrill's interest for $7.525 million, the agreed-upon amount.

The subcommittee is expected to allege that Enron and Merrill excluded the guarantee from their final written agreement in an effort to make it appear that a true sale occurred.

Kelly Martin, a Merrill Lynch senior vice president, is expected to testify before the committee.

Citi, Morgan deny ownership of SPEs

Citigroup
C, -1.04%
Chief Executive Officer Sanford "Sandy" Weill, in response to a request from the Senate permanent subcommittee on investigations last week, said in a sworn affidavit that he had "no personal knowledge of any of the transactions or entities" mentioned by the panel.

Weill said Delta was established by Citibank in December 1993, five years before Weill's Travelers Group acquired Citicorp in a merger. Weill referred questions regarding the entity to Barbara Yastine, chief financial officer of Citigroup's corporate and investment bank, who also filed an affidavit.

Yastine acknowledged that Citibank asked a Cayman Islands law firm to incorporate Delta as a limited liability company, for the purpose of serving as a counterparty in prepaid, physically settled commodities forward transactions involving oil firm Amerada Hess.

Citigroup, however, doesn't "directly or indirectly" own Delta, Yastine said.

"Citigroup does not control Delta. Delta was established at Citibank's request in 1993 as a special purpose entity [or SPE] with the express intention of making it independent of, and unaffiliated with, Citibank under relevant legal and regulatory standpoints," she wrote.

Delta was organized so that Citibank has no ownership in or personnel affiliated with Delta, she said. Delta has an independent board of directors that controls Delta and is responsible for running its business. Also, Delta's memorandum of association expressly authorizes the firm to engage "in any lawful business" approved by its directors, she said.

"Although Citibank, like any company that creates an SPE, did not contemplate that Delta would complete transactions that did not involve Citibank, Delta is not obliged to enter into transactions with Citibank," Yastine wrote.

Yastine acknowledged that Citibank had paid some administrative and legal fees for Delta. But she emphasized that while some of the facts in the affidavit, including the payment of certain fees, "might seem to imply some level of control as that term is ordinarily understood in common usage, these are customary characteristics of independent [special-purpose entities] and do not, in fact, demonstrate control under relevant legal or regulatory standards."

Citigroup shares rose $2.57, or more than 8 percent, to $33.31 in Monday trades.

Similarly, J.P. Morgan Chase
JPM, -0.93%
CEO William Harrison denied that his financial-services firm controlled a special purpose entity known as Mahonia.

"J.P. Morgan Chase does not own Mahonia," Harrison said in his sworn affidavit. "J.P. Morgan has no power to compel Mahonia to enter into a transaction Mahonia does not wish to enter into."

J.P. Morgan told the Senate subcommittee that it created Mahonia in 1992 but that its original intent was not for Enron-related transactions. Rather, the SPE was established "in contemplation of a transaction with one or more other clients that did not proceed."

Mahonia is owned by Mourant & Co. Trustees Limited and controlled by 26 partners, all of whom serve as directors, J.P. Morgan said.

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